Without explicitly mentioning it, the article below offers a greeting: welcome to the post peak economy. The economy can’t grow because energy is too expensive. If the economy isn’t growing, then credit dries up as no one has the money to pay back loans plus interest. If there’s no credit, businesses and people can’t spend. Without spending, there can be no “recovery” in a consumer economy. Without business hiring workers, and the increase in pay that it brings across the board, then prices must fall. Deflation results. (Deflation is a nice way of saying “depression”)

Peak oil has killed our economy. The real problem is – as this article shows – is that commodity prices will rise as they are all based on oil. So even if demand for oil continues to decline, the rate in oil supply decline will offset that and commodity prices will continue to increase. We have never seen something like this – our whole economy is being turned inside out.

We need to be preparing here in Lex – we are not immune.

Inflation Down, Deflation Up

by Mark Hulbert
Tuesday, July 20, 2010provided by

Commentary: Leading money manager now believes deflation is coming

The gold bugs acquired a formidable opponent earlier this week.

He is Jeremy Grantham, chief investment strategist at Boston-based GMO, a money management firm. His quarterly letters to clients are “must reads” on Wall Street, in much the same way that Warren Buffett’s annual letters to shareholders are endlessly dissected and analyzed.

In his just-released letter, Grantham wrote: “Well, I, for one, am more or less willing to throw in the towel on behalf of Inflation. For the near future at least, his adversary in the blue trunks, Deflation, has won on points. Even if we get intermittently rising commodity prices, which seems quite likely (mine), the downward pressure on prices from weak wages and weak demand seems to me now to be much the larger factor.”

To be sure, Grantham up until now hasn’t been a die-hard inflationist. But, by his own admission, he previously had been “mesmerized by the potential for money supply to increase dramatically, given the floods of government debt used in the bailout.”

What changed his mind, he says, is persistent weakness in loan supply and loan demand, along with a slowing in the velocity of money and a mounting political momentum, particularly in Europe but also in the U.S., to favor government debt reduction over economic stimulus.

“Suddenly (for me), it is fairly clear that a weak economy and declining or flat prices are the prospect for the immediate future,” Grantham wrote.

Of all these factors, Grantham hints that the trend towards fiscal conservatism was the one that he least expected — except in Germany, which he says was not surprising.

“You don’t have to be a passionate follower of Keynes to realize that to rapidly reduce deficits at this point is at least to flirt with a severe economic decline,” he wrote. In fact, he adds, the imminent slowdown “looks downright frightening.”

You might deduce from Grantham’s admission to the deflation camp that he is now recommending an increased allocation to bonds. But that is not the case. On the contrary, he writes that “fixed-income is desperately unappealing” right now.

That’s in part because he bases his recommended asset allocation on his forecast of not only what will happen in the immediate future, but over the next seven years. And he is not projecting that deflation will be with us forever.

So even though he is not forecasting a huge, negative long-term return for bonds, as are advisers in the inflation camp, he is not projecting big gains either. His seven-year forecast is for U.S. government securities to provide a real return of just 0.1% per year.

If we’re likely entering a frightening economic decline, and bonds are “desperately unappealing,” where does Grantham recommend that clients put their money? His favorite asset class is “U.S. high-quality stocks,” by which he generally means value stocks instead of growth stocks, and large cap over small — stocks which on the whole did not participate in the market’s extraordinary rally that began in March 2009.

Grantham says that such stocks should decline by less than the market during declines, and are thus worthy of our consideration in their own right. In addition, he believes that an even surer bet going forward is that high-quality stocks will outperform low-quality issues.

Though Grantham does not mention any particular securities in his latest quarterly letter, an idea of the kind of stocks that he likes right now is provided by the ones most heavily owned by GMO mutual funds. They are, according to Morningstar: